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Julie M. Sturgeon: Avoid early withdrawal penalties on your IRA

It’s Your Money

Posted: September 30, 2009 4:53 p.m.
Updated: October 1, 2009 4:55 a.m.
There are times you may need to tap into your IRA earlier than planned ... and there are ways to do so without paying any penalties.

Of course, you will still owe the tax but you can avoid the 10 percent Federal and 2.5 percent California penalties.

Buy a House — You have a total lifetime limit of $10,000 on the amount you can claim from the penalty exemption to purchase or build a home. To qualify, the home will just be used as your principal residence and you cannot have owned a home within the previous two years.

The tax break is available for qualifying expenses of other family members, such as your child, spouse, grandchild or parents of you or your spouse. If you are married and you and your spouse are first time home buyers, you can each pull $10,000 from your IRA accounts, giving a $20,000 total penalty free.

Disability — Money can be withdrawn in the event the IRA owner becomes permanently disabled. To qualify for the exemption, an individual’s disability must be long-term and preclude him/her from engaging in gainful employment as defined by the IRS code.

Medical Expenses — Withdrawals from an IRA to pay for qualified medical expenses avoid the early withdrawal penalty. To qualify, the expense must be unreimbursed medical expenses greater than 7.5 percent of your adjusted gross income. You do not need to meet the 7.5 percent limit if you have been out of work for over 12 weeks and use the funds to pay for health insurance coverage.

Higher Education Expense — Using your IRA to help pay for college expenses may be viewed by many as a great investment in the future. Distributions prior to 59.5 will not trigger the penalty if the funds are used to pay for qualified education expenses for you, your spouse, children or grandchildren. Qualified expenses include tuition, fees, books, room and board, supplies and equipment. The student must be attending school on a full time basis (12 units).

Job loss — You lost your job and received unemployment compensation for 12 or more weeks in succession.

Death of  IRA Owner — Inherited IRA’s are not subject to the penalty.  If you are a spousal beneficiary and need distributions from your deceased spouse’s IRA for support prior to 59.5, you may want to leave the assets in your spouse’s IRA account until you are 59.5. If you elect to roll the IRA into your own account prior to attaining age 59.5, you will no longer be exempt from the early distribution penalty.

Substantially equal payments — If you take regularly scheduled payments from your IRA account, these distributions are calculated based on your life expectancy or a joint life expectancy with your beneficiary. Payments must be made at least annually and cannot be changed for at least five years or until you are 59.5.

There is one catch to these qualifying exemptions; the holder of an IRA is subject to a five year waiting period (measured in tax, not calendar, years).

An investor could not, for example, deposit $3,000 in their IRA this year and withdrawal it next year penalty-free even if it would otherwise qualify as an exemption.

Julie M. Sturgeon is a certified public accountant in Valencia specializing in individual and business tax issues. Her column represents her own views and not necessarily those of The Signal. “It’s Your Money” appears Thursdays and rotates between a handful of the valley’s financial professionals.


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